Since this did not impact the Zacks Consensus, some upside
versus estimates was expected. Share prices appreciated 3.1% in
after-hours trade.

Revenue

Revenue of $17.41 billion was down 16.7% sequentially and up
6.0% from last year, exceeding estimates by 1.3%. All segments
contributed to the sequential decline, but only Entertainment &
Devices did not contribute to the increase from last year.

Segment Specifics

The
Windows
and Windows Live Segment generated 27% of Microsoft's quarterly
revenue, down 2.4% sequentially and up 4.0% year over year. Given
PC unit growth of 2-4% (management estimate), it appears that
Microsoft grew faster than the market. Enterprise was again very
strong, the 8% growth driving quarterly results for the
segment.

The strong performance indicates that the enterprise refresh
continues (Windows 7 now in 40% of desktops). Management also
stated that volume licensing growth was up double-digits. On the
consumer side, netbooks remained a drag given stiff competition
from tablets, particularly
Apple's
(
AAPL
) iPad. However, consumer excluding netbooks was up 6%.

Another encouraging data point was the OEM premium mix, which
was up 4 percentage points. Overall, both market growth and mix
worked in Microsoft's favor in the last quarter, with the market
growth and increasing attach rates encouraging OEMs to build some
inventory.

The
Microsoft Business Division
, which generated 33% of revenue, fell 7.4% sequentially, while
growing 10.7% from last year. Office 2010 adoption is very strong.
The annuity side of the business was the major driver of the
increase from last year (up roughly 13%), helped by increase in
transaction-based sales of around 5%.

Microsoft stated that other products such as SharePoint,
Exchange and Lync were all up double-digits from last year.
Microsoft's success with CRM could give
Salesforce.com
(
CRM
) something to worry about. In the last quarter, Dynamics CRM grew
over 30%, with customers touching 33,000 and users touching 2.25
million.

The
Server & Tools
segment, at 26% of total revenue, was down 4.2% sequentially and up
11.4% year over year. Microsoft's multi-year licensing revenue grew
at a high-teens percentage rate year over year, with SQL server up
in the high-teens and the premium mix up over 30%. Windows Server
Premium was up in the high-teens and System Center up 20%.
Microsoft also remains optimistic about Azure.

Overall trends indicate continuing strength in the enterprise
(enterprise services were also up 21%). Virtualization and cloud
computing are proving to be very beneficial for Microsoft's S&T
business.

Microsoft generated 9% of revenue from the
Entertainment & Devices
segment, down 61.9% sequentially and 16.5% year over year. The
greater-than-expected decline was attributed to the weak gaming
market, although Microsoft remained positive given its 42% market
share (1.4 million units sold in the last quarter).

Microsoft is doing plenty here, expanding TV content, enhancing
Xbox LIVE experiences and announcing new phones using its latest
OS-Lumia from
Nokia
(
NOK
) and Titan II from HTC to be available on the
AT&T
(
T
) network . Xbox Live memberships reached 40 million in the
December quarter (not updated by Microsoft in the last
quarter).

All these subscribers are able to access television content
acquired through recent partnerships. However, while LIVE may be
considered successful, the phone OS has not yet yielded desired
results. Skype, acquired from
eBay Inc
(
EBAY
) in 2010 had minutes touching 100 billion, up 40% from last
year.

The
Online Services
business, or online advertising, generated 4% of revenue, down 9.8%
sequentially and up 9.1% year over year. We think that Microsoft is
investing in technology and innovation and it is this work that is
improving user experience and helping Bing take some share in the
U.S. (up 140 basis points year over year). The partnership with
Yahoo Inc
(
YHOO
) remains on track, with increasing ROI for advertisers. But
monetization remains below expectations.

Operating Results

Microsoft's gross margin of 77.3% jumped 429 basis points (bps)
sequentially and 102 bps year over year. The gross margin is
closely related to the mix, since margins on hardware and software
products differ widely. In the last quarter, low-margin Xbox
sales declined more than expected, while high-margin enterprise
grew more than expected. The search agreement with Yahoo
remains an offsetting factor, raising online services and traffic
acquisition costs.

Operating expenses of $7.08 billion were down 2.4% sequentially
and 5.4% year over year. The operating margin of 36.6% dropped 166
bps sequentially and grew 187 bps from last year. All expenses
increased sequentially as a percentage of sales (because of the
revenue decline), offsetting the significant decline in cost of
sales.

However, R&D increased the most, followed by S&M and
then G&A. All except R&D were down as a percentage of sales
from the year-ago quarter.

The company generated a pro forma net income of $5.1 billion, or
29.3% net income margin compared to $6.6 billion, or 31.7% in the
previous quarter and $5.2 billion, or 31.8% in the year-ago
quarter. There were no one-time items in the last quarter.
Accordingly, the GAAP EPS was same as pro forma at 60 cents
compared to 78 cents in the December 2011 quarter and 61 cents in
the March quarter of 2011.

Balance Sheet

Inventories were up 4.5% to a normal level again, which caused
inventory turns to go from 16.7X to 11.2X. Days sales outstanding
(DSOs) went to 57, down from 60 at the end of the December
quarter.

Microsoft ended with a cash and short-term investments balance
of $59.5 billion, up $7.8 billion during the quarter. The net cash
position was around $5.67 a share, up from $4.74 a share at the
beginning of the quarter. In the last quarter, the company
generated $9.59 billion in cash flow from operations, spent $1.02
billion on share repurchases, $1.68 billion on dividends, $84
million on acquisitions and $749 million on capital assets.

Guidance

Microsoft lowered the fiscal 2012 operating expense guidance by
0.2 billion to $28.3-28.7 billion. Opex in 2013 is expected to be
up 6% to $30.3 to 30.9 billion.

Key Takeaways

The key takeaway from Microsoft's third quarter was the strength
in the PC market. HDD shortages had a less-than-expected impact on
the PC market and enterprise refresh rates were particularly
strong. This drove the revenue surprise, despite EDD falling below
expectations.

We expect the PC market to remain buoyant in the next quarter
and benefit from Windows 8 in the second half. Add to this a strong
business division, growing opportunities for S&T, growing Bing
market share and continued initiatives in EDD and we really like
where the company is now. At a P/E of 51.7X, Microsoft shares look
cheap.

Of course, we recognize the danger of tablets that are still
largely based on iOS or Android, since these devices are eating
into its netbook sales. We expect this phenomenon to continue
because of the popularity that iOS and Android-based devices have
already encountered. We think this will take time to overcome and
we therefore have a long term Neutral recommendation on the
stock.

In the near term however, we expect growing optimism and believe
that positive estimate revisions could raise the Zacks Rank from
the current #3, which implies a Hold recommendation in the
short-term (1-3 months).

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